Thursday, October 22, 2009

Approaching Book Value

Over the last year, we have discussed many stocks that have appeared to trade at significant discounts to their intrinsic values. But lately, undoubtedly due in part to the market's rally, we find ourselves discussing previously downtrodden stocks that are actually approaching their intrinsic values. The latest example of this is Melcor (MRD), a property developer and property manager in the western part of North America.

This company operates primarily in Alberta, a province rich in oil. When oil prices are high (low), Alberta's economy is strong (weak). While energy prices are volatile, the market's (over)reaction to energy prices appears to be even more volatile, as we saw when we looked at Melcor's price to book over the last several years. At that time, Melcor traded at a 40% discount to its book value. While it's book value hasn't changed, the market value of the stock has almost doubled, bringing it to a level near its book value!

One wouldn't value Microsoft or Intel based on its book value, so why place so much emphasis on book value when it comes to Melcor? While land and property prices do fluctuate to some extent, their book values act as a reasonable proxy to market value, particularly if the land was purchased recently. This valuation metric can be used effectively to value homebuilders, for example.

For Melcor, the value of its assets is probably higher than its stated book value. This is due to the fact that some of Melcor's properties were purchased long ago and their prices have therefore appreciated. This makes it all the more surprising that this company can trade at such a large discount to its book value. Even if property prices in some of its areas were to drop by 20% or more, there is no reason why Melcor should trade at just half of its book value! Yet the market provided such an opportunity just a few months ago, and will likely do so again in the future.

But for now, since Melcor has risen to a level commensurate with its book value, much of the upside potential in the stock is now gone. As such, some investors may choose to sell and deploy the capital to situations where great upside potential still exists.

Disclosure: None


Anonymous said...

Yo sai, gr8 work dude! I discovered u r blog a few weeks ago and was immediately hooked, i was quite amazed wen i realized sum value investors do speak english(believe me sumtimes it looks as if they do it to delibrately complicate things) . I learn sumthing new everyday and am able to use it in my investment analysis, its sorta like im gettin paid to read ur thoughts! Anyway kud u pls tell me how can i invest in ur fund? I 2 intend to b a v i like u , kud u pls recommend wot courses might b helpful wen i join college next year( im 17 and live in new delhi, india so unfortunately wudnt b able 2 go 2 columbia 2 learn from d masters) .waitin for ur response urs sincerely, Rayhaan (p.s. After reading ur posts i have come across a potentially gud investment here,can i discuss it here?)

Saj Karsan said...

Thanks for the kind words, Rayhaan!

Unfortunately, the fund is not available to the public at this time due to securities regulations. If that changes, I will post that news on the blog though.

The courses I would advise you to take are accounting, finance (but with an eye towards recognizing if you are taught things that aren't logical) and a course on corporate financial reporting.

Good luck!

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